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Fed Is Probing Foreclosure Practices, Bernanke Says

ARLINGTON, Va. (CN) - Federal regulators are investigating foreclosure practices at large financial institutions to see if flawed policies are leading to improper foreclosures, Federal Reserve Chair Ben Bernanke said Monday at a housing finance conference. He said he expects preliminary results next month.

Bernanke said the housing crisis hit the country especially hard because of the high cultural importance of homeownership in the United States. Its importance, coupled with government incentives like tax breaks and mortgage insurance, caused the homeownership rate to balloon from 45 percent in 1940 to a high of 69 percent in 2004.

Bernanke cited research that homeownership bolsters community involvement, graduation rates and neighborhood stability.

But, he cautioned, homeownership "is only good for families and communities if it can be sustained." He said the agency is looking at the effects of foreclosed and vacant properties on communities.

"Now, more than 20 percent of borrowers owe more than their home is worth and an additional 33 percent have equity cushions of 10 percent or less, putting them at risk should house prices decline much further," he said. "With housing markets still weak, high levels of mortgage distress may well persist for some time to come."

Bernanke touted the Fed's locally based efforts to help to prevent foreclosures, such as promoting fair and equal access to banking services, holding "mega events" for troubled borrowers and allowing unemployed homeowners to stay in their homes by letting them list unemployment insurance benefits as income to qualify for federal mortgage assistance programs.

Speaking after Bernanke, experts called for less government involvement in the housing market.

David Scharfstein, a professor at Harvard Business School, said the government's goal of making homes readily affordable helped spur the housing crisis by injecting too much credit into the housing system, especially from 2001 to 2006. He said the government's primary role in the housing market should be to reduce excess volatility in the supply of housing credit, extending it in times of crisis but contracting it in times of excess, much like it does for the larger economy.

He called for an expanded private securitization market with the government as a "lender of last resort," guaranteeing mortgages but holding a small market share when the market is good and a larger share during times of crisis.

He also advocated for mortgage servicers to have their "skin in the game," or a stake in the mortgages held on their balance sheets themselves so they are not motivated to foreclose, but rather to negotiate with borrowers.

"This is no small task," Scharfstein said.

Andrew Davidson, founder of a mortgage consulting firm, also called for a smaller government role in the housing market, but supported keeping some form of government guarantee on mortgages.

Martin Eakes, CEO of the Center for Responsible Lending, said the two government-sponsored mortgage giants, Fannie Mae and Freddie Mac, should be fundamentally reformed but not discarded.

"GSE portfolios did not create the taxpayer losses," Eakes said, adding that just because they expanded their portfolios to $900 billion during the lead-up to the housing crisis did not mean they should have no portfolio "whatsoever."

He said the solution was a new regulator, setting real capital standards, attaching an explicit guarantee on mortgage backed securities, and transferring assets and liabilities to a new corporation.

"We already have a new regulator and we have the authority to set real capital levels and the two remaining could be done in a weekend," Eakes said.

"I don't know why all you guys in Washington keep making this so hard. It is just so simple."

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